Foreclosure & Contagion

The second in the series of my blog entries on foreclosure is on contagion. For contagion the start is a quotation of excerpts from a report on contagion research The Contagion Effect of Foreclosures: The Neighborhood Impact of Subprime Lending, Predatory Lending and Foreclosure ". The quote is “Some neighborhoods see a concentration of foreclosures, the number of distressed properties in close proximity to a given property also has an impact on home value."

The gist of it is that as housing prices decline from homeowners’ defaults, there is a spillover effect of foreclosures on neighborhoods. “Depending upon variances in time and space, foreclosures can depress home prices by as much as 10 percent. When taking into consideration the number of distressed properties in close proximity to a given residence, the residence will decrease in value by an average amount of 1% per distressed nearby property.” Based on average home prices, nearby foreclosures reduce the value of each neighboring home by $5,000 on average. “In addition, inner cities and areas where new construction is prevalent appear to be the hardest hit by foreclosure and the related contagion effects. While there is considerable evidence of this contagion effect, there is little evidence of foreclosure cascading -- where the number of foreclosures in a given neighborhood reaches a ˜tipping point and the foreclosure rate begins to increase rapidly. Anecdotal evidence suggests that when foreclosures in a given neighborhood reach this "tipping point" the entire neighborhood can experience hardship due to a lack of residents to generate fees and taxes needed to support basic services.” The article provides links to the research cited. The Black Swan effect has not been revealed in the academic studies, but the localities studies are limited.


The Neighborhood Impact of Subprime Lending, Predatory Lending and Foreclosure- Stephanie Rauterkus

A growing body of evidence suggests that subprime lending, predatory lending and foreclosure affect neighborhood home values. In “The Neighborhood Impact of Subprime Lending, Predatory Lending and Foreclosure” my colleagues and I discuss what we know so far and areas requiring further research. With respect to subprime and predatory lending, researchers have discovered linkages between these practices and an increase in default probability. These defaults tend to have a spillover effect on entire neighborhoods. While several specific practices have been identified as counterproductive with respect to increasing homeownership, few (if any) regulatory measures have been shown to effectively combat these problems. Much of the issue in this arena tends to revolve around clear definitions of subprime and predatory lending and the related issue of determining how to identify the practice when it occurs.

Various studies have quantified the impact of foreclosures in the range of two to ten percent of home value. Evidence of significant clustering also exists in certain areas. Several states -- Arizona, California, Florida and Nevada in particular -- have experienced unusually high foreclosure rates. Within cities, clustering has also been found in new construction areas on the outskirts of major metropolitan areas. This clustering too has been shown to bring down home values. While estimates differ regarding how close a distressed property must be to a given home to affect its value, the impact has been estimated to be a 1% decline in value per nearby distressed home! When these impact figures are applied to the national housing stock, this means that distressed properties reduce the value of nearby properties by $5,000 on average. Anecdotal evidence shows that concentrated foreclosures can have a devastating effect on neighborhoods. Researchers have investigated this phenomenon to determine if a ‘tipping point’ exists where the foreclosure rate increases at an increasing rate. To-date, no such cascading effect has been found.

Much additional work is needed in this area. More research is needed to explain the means by which foreclosure spreads within and across neighborhoods. Specifically, we need answers to several questions. Why are there large regional differences in mortgage performance? Does state and local regulatory behavior affect loan behavior? How are age-income-ethnic characteristics related to ownership, loan issuance and performance? What role did incentives, moral hazard and adverse selection play in lending behavior? Related to this question, policy-makers have also asked to what extent foreclosures are the result of a “push me” phenomenon where borrowers are pushed up into more expensive homes or a “pull me” phenomenon where brokers are pulled to write more (and larger) loans. How extensive are risk externalities generated by the housing market? That is, what is the impact of risky behavior in housing markets on the broader financial markets? How do we stabilize the housing markets and what roles should state, local and federal entities play in this effort?

Posted by Maury Seldin on behalf of Stephanie Rauterkus, Ph.D.

Complex Systems - Jack Lillibridge

This is a follow-up to our discussion in the Seminar on Strategic Decision Making and my presentation of comments on some books relevant to how concepts from psychological economics may contribute to understanding the current economic situation and what might be done about it. My presentation focused on three books; Predictability Irrational: The Hidden Forces that Shape Our Decisions by Dan Ariely; The Mind of the Market: How Biology and Psychology Shape Our Economic Lives by Michael Shermer; and Nudge: Improving Decisions About Health, Wealth and Happiness by Richard Thaler & Cass Sunstein. However, in the follow-up presentation I tied the discussion to complex systems which you mentioned in your main essay, Subprime Crisis Strategic Decision-Making: A Discussion of What Went Wrong and Strategies to Deal with It and which Paul Carr discussed in his presentation which included Complexity, Risk, and Financial Markets by Edgar Peters.


The theory of complex adaptive systems identifies component processes that undergird these two aspects of nature, such as positive and negative feedback. A notable instance of a complex adaptive system is a living organism, which includes elements of interaction with the environment and of memory.

This view of nature is characterized by two interrelated aspects. One is characterized by equilibrium, balance, continuity, renewal, etc., resulting in maintaining the existing order. I call this first aspect stability. Nature is also characterized by creativity, learning, exploration, risking, etc., resulting in a new, more complex, order. I call this second aspect growth. These aspects are both complementary and mutually interacting, relating to a dynamic ongoing overall process.

There is a dynamic process described as part of the theory that perhaps will contribute to an understanding of the current economic crisis, especially how it could occur as it did. This dynamic process is the time course from a persisting, stable order, through a transition or threshold, to a new, persisting stable order that is more complex. There are at least three things to understand: what could cause a transition, how could the transition occur, and what might the new order look like. For instance, what triggered the transition and what will influence the kind of new order that results?

Posted by Maury Seldin on behalf of Jack Lillibridge. Dr. Lillibridge has a Ph.D. in Psychology.